Show captionForecasts that wages will grow more slowly than previously expected suggests the Bank of England governor, Mark Carney, is in no hurry to raise interest rates. Photograph: Suzanne Plunkett/AFP/Getty Images

The prospect of an interest rate rise in 2014 appeared to diminish on Wednesday after the Bank of England admitted it is in the dark about the true state of the British economy.

The August inflation report laid bare the dilemma over the timing of the first rise faced by the Bank's policymakers, who are struggling to reconcile rapidly falling unemployment and record employment with very weak wage growth.

On the one hand, members of the Bank's rate-setting monetary policy committee (MPC) revised down their estimate of spare capacity in the economy to 1% of GDP from a May forecast of 1-1.5%, as employment growth rockets.

Governor Mark Carney and his colleagues have made it clear that borrowing costs – on hold at 0.5% since March 2009 – will have to rise before spare capacity is fully used up.

But on the other hand, wage growth has been much weaker than expected, prompting the MPC to halve its forecast for pay growth to 1.25% by the end of 2014.

With inflation expected to remain just below the 2% target by the end of this year, it means real pay for the average British worker is expected to fall for the rest of 2014, prolonging the squeeze on household budgets.

Carney signalled that pay growth will be crucial to the timing of the first rise amid conflicting signals.

"Pay growth has been remarkably weak, even as unemployment has fallen rapidly.

"In light of the heightened uncertainty about the current degree of slack, the committee will be placing particular importance on the prospective paths for wages and unit labour costs."

Carney repeated the Bank's well-rehearsed line that when rates do start to rise, increases are likely to be "gradual and limited". However, in a warning shot that households accustomed to low borrowing costs should prepare for higher borrowing costs, he added: "That's an expectation, not a promise."

The pound fell to a four-month low against the dollar following Carney's comments and the weaker outlook for wages, as markets interpreted them as a signal that a 2014 rate is looking increasingly unlikely.

Sam Hill, senior UK economist at RBC Capital Markets, said: "The clear signal that we take from [the August] report is that the odds of a move before the end of 2014 have reduced further. We retain a forecast that the first 25 basis point hike will be in February 2015."

In June, Carney was accused by Pat McFadden, Labour MP and member of the Treasury select committee of behaving like an "unreliable boyfriend", giving too many mixed messages on the likely timing of the first rate rise.

Following the publication of the August inflation report, Kathleen Brooks, research director at forex.com said he was behaving more like a "fearful fiance". "He has popped the question and put the prospect of a rate hike out there, but is yet to commit to a date for the big day."

The Bank nudged up its forecast for growth in 2014 to 3.5% from 3.4%. Similarly it raised its 2015 forecast to 3% growth from 2.9%. Carney said that although the economy is "returning to a semblance of normality," risks remain – including heightened geopolitical tensions and weak recovery in the eurozone. He also stressed it was unclear how rising interest rates would affect the economy by weighing on domestic demand.